Wednesday, July 9, 2008

Making Money Even if the Market does not Go Up.

Nobody knows for sure which way this market is headed in the short run. My firm’s motto is “Being prepared is more important than making predictions”. We cannot predict market movements with certainty, but we can assess or estimate probabilities-that is part of being prepared. But it must be remembered that an 80% probability of something happening is still 20% from being certain.

In my previous blog, I mentioned that it looks like we might already be in a period that is similar to the 1970’s. Casual conversations with friends or family and business conversations with clients invariably displays a level of pessimism and fear not seen since Jimmy Carter was President. Fear of inflation, fear of losing a job or business losses, fear of general economic decline.

Inflation is obviously present in the price of petroleum, commodities, and food. So, what’s the cause? Extraordinary global economic growth is the reason. Developing economies are experiencing “demand pull” inflation with rising wages. Developed economies are experiencing “cost push” inflation which is restraining wages. Demand pull inflation tends to feed on itself, generating more inflation and a boom/bust cycle. (The recent home price bubble in the US is an example.) Cost push inflation tends to result in an economic correction and a general pessimistic feeling--that of "being out of control". (Having to pay more for our corn flakes because the farmer is now getting $7 a bushel for his corn instead of $3.)

Oil and commodities are priced high because of strong demand. According to Fed President. Janet Yellen, since 2000, world demand for oil has increased by 11 million barrels a day (14%) without a corresponding increase in supply. And commodities that are not traded by speculators are up as much or more than oil that is traded by speculators. We have a classic demand pull inflation going on. Probability is high that such booms are followed by busts. I personally think that commodities and oil can continue rising, but the probability is better than 50% that we are very near the top. Be careful not to jump on the bandwagon just before it falls of a cliff.

Although we like to think of real estate as an investment, for the vast majority of people, real estate is a cost. As the price of real estate declines, it creates deflationary effects. Housing is in the process of becoming more affordable. While the price of gasoline and food rises, the demand for most everything else declines. This also can cause deflation. While the price of fuel may cause producers to want to raise prices, there has to be demand or nothing gets sold. Money supply growth drives inflation and a decline in the money supply creates deflation. The credit correction we are experiencing is causing huge pressures toward a reduction in the money supply--offset (maybe only in part) by aggressive moves by the Fed. The probability is high that risks of deflation are almost the same as inflation.

Inflation produces winners and losers. You may not like paying higher prices for food, but even though few admit it, farmers are experiencing better results than they have seen in decades. While this is a difficult market for home-builders, there is still demand for housing and apartment owners are doing pretty well. This is the point of the mantra—“You must own a diversified investment portfolio”.

So as Franklin Roosevelt said, “We have nothing to fear but fear itself”. And, my view is that markets are more affected by fear of the unknown than fear of any known event or trend. Although we never really know the future with certainty, we feel better when we think we do! In periods of fear, be "courageously cautious" and seek out bargains that will be the source of out-sized future returns.


It is highly probable that markets are closely correlated with corporate profits. And corporate profits have been declining since the 2nd qtr of 2007. It is highly probable that corporate profits may continue to decline or remain flat for quite some time. So, our investment portfolios should be adjusted to focus on diversified sources of rising income. These sources are companies that have corporate profits that are predictable and relatively stable.

There are three sources of investment income: interest, dividends, and capital appreciation. Most likely interest and dividend income will be relatively more important in the near term than they were in the boom periods of the 1980’s and 1990’s. Choosing companies that generate real income and reinvesting that income will produce rising income over time. Choosing the correct mix of dividend and interest income will depend on each individual’s circumstances. More “certain” income from fixed income investments is generally recommended if you are taking income from your portfolio. This has become relatively more important. And, given the deflationary pressures discussed above, a laddered portfolio of fixed income investments will probably approach historical norms for total returns.

So, is the market going up or down? History teaches that it is probably going up in the long run. And we believe that the current market is likely to move up as we approach the end of summer. (60-80% probable) However, given political risks associated with the elections (because of changes in tax policy) and the chance that we are near the end of a boom period in developing countries, we are advising a slight reduction in international exposure and more emphasis on stocks that pay attractive dividends. Look for opportunity where prices have fallen and dividends are higher yields than historical averages-and where the dividend would still be attractive even if cut by 30-40% in the short run.

Take a look at companies like FR, DRE, FPL, IBDRY and BMY. (Not a recommendation—suitability is determined by many factors and a decision to buy or sell should not be made until having first consulted with a qualified financial advisor who will help assess your current situation and risk tolerance.) Companies that provide necessities and where the “trend is your friend” are the stocks you want to own going into the near future. BMY is in health care and will benefit from the aging population—even with more government controls on costs. FR and DRE are REIT’s that benefit from the trend of growing world trade. FPL and IBDRY are electric utilities that are leaders in alternative energy from wind. Avoid speculative positions and holdings--the chance of being disappointed is very high.

By carefully selecting the correct assets and allocation, you can make money, even if the markets do not go up.

Note: Strout and/or Strout's family have positions in FR, DRE, IBDRY and BMY.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.






Tuesday, July 1, 2008

Stay the Course and Look for Opportunity

  • It is easy to be an "investor" when your account continuously increases on a regular monthly and quarterly basis. Obviously, being an "investor" from October 2007 to now is not quite so pleasant. June was "scary" for almost everybody.
  • I like to say that the price you pay for long term growth in your portfolio is having to experience these downturns. Sometimes they last for months...sometimes for years.
  • Warren Buffet has supposedly stated "Occasional outbreaks of ...fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both in duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and greedy when others are fearful." The VIX still below its highs notwithstanding, there is a lot of fear out there. For those that have cash on the sidelines, clearly it is near the time to become greedy! (Keep in mind that every day we have the chance to buy, sell or hold. Staying the course is essentially the same as buying your existing portfolio.)
  • In any case, this is not the time to be liquidating and probably not even the time to be sitting on the sidelines except...Be sure you have enough cash and income to "ride out the storm" without selling good investments at the wrong time. Enough in today's environment is enough for the next 3-5 years.
  • If we are to learn from history, it is probably useful to revisit the early 1970's. (A serious oil "price shock" occured then, like we are now having. Except then, we had to wait in lines to get gasoline. This was when the 55 mph speed limit was imposed.) Serious long term investors, even buying at the peak before the downturn were rewarded for staying the course and owning good quality investments. But, the duration of the "storm" starting in January 1973 was three years. The S&P500 fell from 119 in January to 97 in November 1973 and then to 64 in September 1974, rising back to around 100 in January 1976. By January 1983, ten years from the previous peak, the S&P500 had risen to 145.
  • A good quality investment, here defined for discussion purposes as American Funds Income Fund of America, a mix of dividend paying stocks and good quality bonds (AMECX) turned in a better performance: $100,000 (Net Asset Value) on November 30, 1973 weathered the two to three year storm, falling to $94,000 at the end of 1974 and rising above $100,000 in 1975. By January 1983, after all dividends were reinvested for the ten year period, the $100,000 had grown to around $322,000. (According to American Funds Hypothetical-do not invest before reading the prospectus, reviewing all required disclosures, and meeting with a qualifed Financial Advisor. Be sure that your risk tolerance and complete financial situation is reviewed to determine that any investment is suitable for you.)
  • Another possible good quality investment (here again defined for discussion purposes) would be American Funds American Mutual Fund, a diversified stock mutual fund. (AMRMX) A purchase of $100,000 at near the peak of the market around the begining of January 1973, after the 3.5% sales charge leaving $96,500, fell to $72,000 by the end of 1974. The investment, with dividends reinvested rose to $322,000 by January 1983. (Again according to American Funds Hypothetical-do not invest before reading the prospectus, reviewing all required disclosures, and meeting with a qualified Financial Advisor. Be sure your risk tolerance and complete financial situation is reviewed to determine that any investment is suitable for you.)
  • The index fell 34%, and gained a total of 49% in ten years. (97 to 64 to 145) AMRMX and AMECX fell less, and gained 322% in 10 years. (AMRMX: 100 to 72 to 322- Jan '73 to Jan '83 and AMECX: 100 to 94 to 322- Nov '73 to Jan '83). Keep in mind, history and past performance do not predict the future. This is not a recommendation of AMRMX or AMECX. It is an illustration (for discussion purposes) of how money can be made, even if the stock market does not go up very much by investing in good quality investments with the help of professional management.
  • Experienced investors are only fearful when markets are too high and when everybody seems greedy. Experienced investors see market drops, dips, corrections and bear markets as opportunities.
  • When you are in the middle of a downdraft, like now, there will be no shortage of "Doom and Gloom" and claims or fears that "This time it's different". The 1970's were scary. 1987 was scary. 2002 was scary. Yet, the markets recovered in each case.
  • In closing, investing is not about what happens in 1 year or 3 years. Investing is more about what happens over 10 years. Be sure you have cash and/or income so that you can Stay the Course and Look for Opportunity.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.